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Portfolio Risk and Return: Part I: Presenter Venue Date
Portfolio Risk and Return: Part I: Presenter Venue Date
Periodic
Income
Capital Gain
or Loss
Pt Pt 1 Dt Pt Pt 1 Dt
R
Pt 1
Pt 1
Pt 1
Capital gain Dividend yield
105 100
2
R
5% 2% 7 %
100
100
AVERAGE RETURNS
Average
returns
Arithmetic
or mean
return
Geometric
mean return
Moneyweighted
return
T 1 Rit 1
t 1
MONEY-WEIGHTED RETURN
CF0
CF3
CF1
CF2
0
0
1
2
3
(1 IRR)
(1 IRR) (1 IRR)
(1 IRR)
- 100
- 950
350
1270
0
1
2
3
1
(1 IRR) (1 IRR)
(1 IRR)
IRR 26.11%
ANNUALIZED RETURN
rannual 1 rperiod 1
c
Gross returns
Expenses
Net returns
Pre-tax nominal
return
Taxes
After-tax
nominal
return
Population
R
t 1
Sample
R R
T
s2
t 1
s s2
T 1
2
P Var RP Var wi Ri
i 1
w w Cov R , R
N
i , j 1
N
w Var Ri
i 1
2
i
w w Cov R , R
N
i , j 1, i j
Markets are
informationally and
operationally efficient
Violations of the
normality assumption:
skewness and
kurtosis.
UTILITY THEORY
Expected
return
Variance or
risk
1
2
U E (r ) A
2
Utility of an
investment
Measure of
risk
tolerance or
risk aversion
INDIFFERENCE CURVES
An indifference
curve plots the
combination of
risk-return pairs
that an investor
would accept to
maintain a given
level of utility.
E RP w1 R f 1 w1 E Ri
w 1 w1 2w1 1 w1 fi f i
2
P
2
1
2
f
2
i
1 w1 i2
2
P 1 w1 1 w1 i
2
2
i
CAL
E(Ri)
Equation of the CAL :
E Ri R f
E RP R f
P
i
Rf
p
i
Correlation
between assets
in the portfolio
Portfolio risk
Evaluate
assets
Diversify
with index
funds
Diversify
among
countries
Optimal
Investor
Portfolio
Financing
Decision
SUMMARY
Different approaches for determining return
Risk measures for individual assets and portfolios
Market evidence on the risk-return tradeoff
Correlation and portfolio risk
The risk-free asset and the optimal risky portfolio
Utility theory and the optimal investor portfolio